Capital Gains Tax

Context: The recent budget has introduced significant changes to the Capital Gains Tax regime, including the removal of indexation benefits from the Long-Term Capital Gains Tax (LTCG).

Capital Gains:

• Definition: Capital gains refer to the profit or gain that arises from the sale of capital assets, which can be tangible (e.g., land, buildings, vehicles) or intangible (e.g., shares, bonds, copyrights).
• Capital Gains Tax (CGT): The tax on these profits is known as Capital Gains Tax, divided into two main types:

Short-Term Capital Gains Tax (STCG)

• Holding Period: Applies to assets held for less than one year (for listed securities) and less than two years (for all other assets).
• Tax Rate: The Government of India (GoI) has increased the STCG tax rate from 15% to 20% in the recent budget, which is higher than the LTCG tax rate.

Long-Term Capital Gains Tax (LTCG)

• Holding Period: Applies to assets held for more than one year (for listed securities) and more than two years (for all other assets).
  • For listed units of business trusts (REITs, InVITs), the holding period has been reduced from 36 months to 12 months.
  • For gold and unlisted securities (other than unlisted shares), the holding period has been reduced from 36 months to 24 months.
• Tax Rate: The GoI has reduced the LTCG tax rate to 12.5% and exempted capital gains up to Rs. 1.25 lakh (previously Rs. 1 lakh) from paying CGT.
• Indexation: The Centre has eliminated the indexation benefit for calculating LTCG on property, gold, and other unlisted assets.

Advantages of Recent Changes

• Discourage Short-term Capital Transactions: Aims to increase economic stability by discouraging short-term trading.
• Simplified Tax Structure: A single tax rate for LTCG simplifies tax compliance.
• Increased Government Revenue: Higher STCG rates and removal of indexation benefits are expected to boost government revenue.
• Encourages Investment: The increased exemption limit may encourage more people to invest in capital assets.

Disadvantages of Recent Changes

• Higher Tax Burden for Long-term Holders: The removal of indexation benefits results in a higher tax burden for those holding assets over long periods.
• Discourages Long-term Investments: After-tax returns may be lower, potentially discouraging long-term investments.
• Potential Increase in Property Prices: Property sellers might raise prices to offset the higher tax burden.
• Impact on Equity Markets: The removal of indexation might negate the benefits of the LTCG tax reduction.

Indexation

• Definition: Indexation adjusts the cost of an asset to account for inflation over the holding period, resulting in an ‘indexed cost of acquisition.’
• Purpose: By using the indexed cost instead of the original price, the impact of inflation is taken into account, thereby reducing the apparent profit and lowering the tax burden.